LLC vs S-Corp vs C-Corp: The Real Tax Math for Small Businesses
Last updated · Entity Selection
"Should I be an LLC or S-Corp?" is the most common small business tax question in the US. The answer has real financial consequences — choosing wrong can cost thousands in unnecessary self-employment taxes. The three main structures (LLC, S-Corp, C-Corp) have completely different tax treatment, and the right choice depends on your income level, business type, and long-term plans. This guide walks through the actual tax math for each structure at different income levels, with specific calculations that show when each one wins.
The three entity types explained
US small businesses typically choose between three federal tax classifications:
- Sole Proprietorship / Single-member LLC (default): taxed as "disregarded entity" — business income flows directly to the owner's personal Form 1040 Schedule C. Owner pays self-employment tax (15.3%) plus federal and state income tax on the full net income.
- S-Corporation: a tax election (not a separate entity type) made by an LLC or corporation. Business pays the owner a "reasonable salary" subject to payroll taxes, with remaining profits distributed as distributions not subject to self-employment tax.
- C-Corporation: a separate tax entity. The corporation pays corporate income tax (flat 21%) on profits. Shareholders pay personal income tax on any dividends or salary received. Often "double taxation" but with specific benefits for certain situations.
Note: an LLC is a legal entity type, not a tax classification. A single-member LLC is taxed as a sole proprietor by default, a multi-member LLC as a partnership by default, and any LLC can elect to be taxed as an S-Corp or C-Corp by filing the appropriate IRS form.
The self-employment tax problem
The primary reason most small businesses consider S-Corp election is to reduce self-employment tax. Self-employment tax is 15.3% on net business income:
- Social Security: 12.4% on the first $176,100 (2026 wage base)
- Medicare: 2.9% on all net income
- Additional Medicare surcharge: 0.9% on income above $200,000 (single) or $250,000 (married)
For an LLC/sole proprietor earning $150,000 in net business income, self-employment tax is approximately $21,195 (after the 50% SE tax deduction). That's on TOP of federal income tax (~$25,000) and state income tax (varies).
Total taxes on $150,000 of sole proprietor income (California): roughly $62,000 — leaving about $88,000 in take-home. Ouch.
How S-Corp election saves money
An S-Corp election allows business owners to split their income between:
- Salary (W-2 wages): subject to payroll taxes (Social Security 12.4% + Medicare 2.9% = 15.3%, split between employer and employee portions)
- Distributions: NOT subject to self-employment or payroll taxes. Only subject to federal and state income tax.
Example for $150,000 net business income as an S-Corp:
- Reasonable salary: $70,000 (subject to payroll taxes)
- Remaining distribution: $80,000 (NOT subject to SE tax)
- Payroll taxes on $70,000: ~$10,710 (vs ~$21,195 SE tax on full $150K as sole proprietor)
- Savings: ~$10,485 per year
The savings come from NOT paying self-employment tax on the $80,000 distribution portion. At higher incomes, savings grow larger.
Caution: the IRS requires the salary to be "reasonable" — i.e., comparable to what someone doing your work would earn. Paying yourself $20,000 on $200,000 of business income triggers audit risk. See our reasonable salary guide for details.
When S-Corp is NOT worth it
S-Corp election has costs that offset the tax savings:
- Payroll setup and processing: $500-$2,000/year for payroll software or service (Gusto, QuickBooks Payroll, ADP)
- Additional tax return: Form 1120-S for the corporation, typically costs $500-$1,500/year if prepared by an accountant
- Workers compensation insurance: required in most states for W-2 employees (even owners), $500-$2,000/year depending on industry
- Retirement plan complexity: more restricted retirement plan options (simplified SEP-IRA becomes less advantageous, though Solo 401k is better)
- State-level taxes and fees: some states (California, New York, Illinois) charge extra taxes on S-Corps
Break-even analysis:
- Under $40,000 net business income: S-Corp election almost never saves money after costs
- $40,000-$75,000 net: marginal — depends on specific circumstances
- $75,000-$200,000 net: S-Corp election usually saves $3,000-$15,000/year after costs
- Above $200,000 net: S-Corp savings grow but begin to plateau as Social Security wage base is exceeded
For low-income businesses, LLC/sole proprietor is typically the right choice. The savings don't justify the complexity until you're making at least $60,000-$80,000 net per year.
C-Corp: specific use cases
C-Corporations are less common for small businesses because of "double taxation" — the corporation pays 21% corporate tax, then shareholders pay personal tax on dividends. But C-Corps can be the right choice in specific scenarios:
- High-growth startups raising outside capital: most VCs require C-Corp structure for investment. Delaware C-Corps are the standard startup form.
- Businesses retaining significant profits for reinvestment: the 21% corporate rate is lower than top individual rates, so reinvesting in the business rather than distributing is tax-efficient.
- Owners who want strong retirement plan and benefits options: C-Corps have the broadest options for medical expense plans, retirement plans, and fringe benefits.
- Section 1202 QSBS exclusion: for certain startup businesses held 5+ years, shareholders can exclude up to $10 million in capital gains on sale (Qualified Small Business Stock exclusion).
C-Corp is rarely the right choice for a service business, consultancy, or small operation. But for venture-backed tech startups and businesses reinvesting heavily for growth, it can be optimal.
Decision framework
A practical decision tree:
- Net business income under $40,000? Single-member LLC taxed as sole proprietor. Simple, cheap, no unnecessary complexity.
- Net income $40,000-$75,000? Marginal case. Stay as LLC/sole proprietor unless you have other reasons to do payroll (like paying a spouse). The complexity usually outweighs the savings at this level.
- Net income $75,000-$400,000? LLC with S-Corp election is typically optimal. Take reasonable salary + distributions. Save $5,000-$20,000/year in self-employment taxes.
- Raising venture capital or building a startup to sell? Delaware C-Corp from the start. Don't convert from LLC later — it creates tax and legal complications.
- High-income professional service firm ($400K+)? LLC with S-Corp election still generally wins. At very high incomes, the PLLC + S-Corp combination is common.
This is general guidance. Consult a CPA for your specific situation before choosing.
Frequently Asked Questions
What is the difference between LLC and S-Corp?+
An LLC is a legal entity type. S-Corp is a tax classification that an LLC can elect. A single-member LLC is taxed as a sole proprietor by default; electing S-Corp status changes how income is taxed by splitting it into salary (subject to payroll taxes) and distributions (not subject to self-employment tax).
When should I elect S-Corp status?+
Generally when your net business income exceeds $75,000-$80,000. Below that, the complexity costs (payroll processing, extra tax return, workers comp) offset the self-employment tax savings. Above that, S-Corp election typically saves $5,000-$20,000 per year depending on income level.
How much does S-Corp election save in taxes?+
Depends on income and salary level. For $150,000 net business income with a $70,000 reasonable salary, S-Corp election saves approximately $10,500 per year in self-employment taxes compared to sole proprietor. At higher incomes the savings grow but begin to plateau above the Social Security wage base ($176,100 in 2026).
What is a "reasonable salary" for an S-Corp owner?+
An IRS requirement that S-Corp owners pay themselves a salary comparable to what someone doing the same work would earn in their market. Paying too little triggers audit risk. Generally should reflect at least 40-60% of business profits for owner-operators with significant time commitment to the business.
What are the downsides of S-Corp election?+
Payroll setup and processing costs ($500-$2,000/year), separate corporate tax return ($500-$1,500/year), workers comp insurance ($500-$2,000/year), and in some states (CA, NY, IL) extra state taxes. Total cost: $1,500-$5,000/year. Worth it above $75,000 net income, not worth it below $40,000.
Should I be a C-Corp?+
Only in specific situations: raising venture capital (VCs require C-Corp), running a startup planned for sale (Section 1202 QSBS exclusion), or reinvesting heavily for growth. For service businesses, consultancies, and most small operations, C-Corp creates unnecessary double taxation.
Can I change from LLC to S-Corp later?+
Yes, easily. File IRS Form 2553 to elect S-Corp classification. The election typically takes effect for the current tax year if filed within 2 months and 15 days of the year start (or the first day of the tax year you want the election to apply). Converting LLC to C-Corp is more complex and has tax implications.